A week after Bernanke satisfied all the bulls with a major QE announcement the markets lost ground instead of shooting off into the stratosphere.
The Dow finished negative on a Friday for the first time in several weeks and the S&P closed only fractionally lower by -0.11 despite a quadruple witching and S&P rebalance at the close. European markets were positive as it appears Spain is making progress moving towards asking for a bailout. They want to have all their ducks lined up as far as reforms before asking for help. Once they ask for help the ECB, ESM and EU will look at what reforms they have in place and then decide what further reforms they are going to require.
Friday was another light news day and the indexes tried to rally in the morning but faded in the afternoon. I am not surprised. The Dow has fallen on 14 of the last 15 Mondays. That trend will eventually end but you can't blame traders from paying attention to the trend and moving to the sidelines.
There was no economic news of note so investors were left to focus on a couple of earnings reports for trading ideas. Mass Layoffs for August declined slightly from 1,340 events to 1,267. The number of employees impacted fell from 137,420 to 127,454. The decline in the numbers was insignificant but the trend is important. The decline put the three year trend close to a three year low.
Moody's Mass Layoff Chart
The calendar for next week has a lot of events but none are really earth shaking. We will see four more regional manufacturing surveys plus the Chicago ISM (PMI). None of these are as important as the Philly Fed Survey last Thursday, which remained in contraction territory for the fifth consecutive month.
The next revision of the Q2 GDP is on Thursday and odds are good it will be revised down again.
This week will be a positioning week for quarter end and for the earnings cycle just ahead. Window dressing is going to be in full bloom and prior winners will probably be seeing positive money flows early in the week.
One of the earnings surprises moving the market higher at the open was KB Homes (KBH). KB Homes posted earnings of four cents compared to expectations for a loss of 15 cents. KBH benefitted from higher volumes, higher prices as well as tax and insurance gains. The company said the "pace and breadth of the market gained momentum over the summer." Revenue rose +16% to $424.5 million. Home deliveries rose +7% to 1,720. The average selling price rose +8% YoY to $245,000, up +5% from the prior three months. KBH said it was seeing "dramatic improvement" in California. Earnings were helped by a $16.5 million insurance recovery and a benefit of $10.7 million tied to the resolution of a federal income tax audit. Excluding items the company lost -12 cents per share so those that bought the headline number of a profit of 4 cents were uninformed. Shares of KBH spiked +16%.
KB Homes Chart
Darden Restaurants (DRI) reported better than expected earnings and declared a quarterly dividend to push the stock to a new high. Darden earned 85 cents or $110.8 million. Analysts were expecting 83 cents. Revenue rose +5%. Darden had raised prices on some items to cover the higher cost of the food.
Despite the earnings beat the comps were not exciting. Olive Garden same store sales rose only +0.3% due to a failed "Taste of Tuscany" promotion early in the quarter that did not excite diners. Red Lobster saw same store sales decline -2.6%. To counter that decline they are adding more chicken and beef dishes to the menu to raise the non-fish items to 25% of their offerings from the current 8%. In both chains they are increasing the number of lower cost items to reflect the lower spending by consumers. Those buying appetizers as their entre had been rising so they are launching a lot of downsized offerings to cater to smaller or calorie conscious appetites.
Luxury retailer Michael Kors (KORS) rallied to a new high with a gain of +9% after raising guidance for the second time this quarter. KORS said earnings in Q3 should hit 38-40 cents, up from expectations in August of 33-35 cents. Full year earnings estimates were raised from $1.32-$1.34 to $1.39-$1.41. The Kors CEO said the "updated guidance reflects our confidence in the strong momentum of the Michael Kors brand and the continued execution of our key growth strategies."
Competitor Coach (COH) saw its shares fall -4% after Credit Suisse downgraded the company. Coach warned when it last reported earnings that 2012 would be an "investment year" that may not be great for the bottom line. The idea was that luxury retailers were suffering in the down economy. Credit Suisse believes that may be a company specific problem for Coach given the outperformance of KORS.
Apple (AAPL) shares hit a new high in the morning as the first iPhones became available but the morning bounce to $705 did not hold with the close at $700 for a minor gain. The iPhone is getting good reviews except for one area. Apple took the Google Maps application off the phone and replaced it with a maps application by Apple. Unfortunately that application was not ready for prime time. Complaints are flying fast and that took some of the bloom off the bounce. The backlash was so bad that Apple had to issue a formal statement to reassure buyers that Apple maps would get better. Some analysts thought it was arrogant of Apple to arbitrarily remove Google maps and force users into their Apple app before it was ready. Reportedly there are no turn by turn directions and information on public transportation is severely lacking. Selling two million of the phones on the first day at an average price of $650 produced $13.0 billion in revenue for Apple so I am pretty sure they are not panicked by the maps problem.
The picture below is a FedEx package center clogged up with thousands of iPhone 5 boxes.
iPhone 5 Shipping
Meanwhile Google (GOOG) shares continued to rise as the various companies making Android phones are prospering. Apple started the patent war and now it appears everyone has chosen sides and there is safety in numbers. Apple lost a patent case in Germany against Samsung on Friday so just because they won in the U.S. does not mean the rest of the world is just going to give up and concede to Apple.
Apple took a shot at Google by dropping the maps and Google is getting the last laugh. Apple took an application more than 35% of users love and kicked it and them to the curb. For people who love Google maps that is a reason to buy an Android instead of the iPhone.
Which of these charts would you buy? I prefer Google.
Starbucks (SBUX) said the Verismo single serve coffer maker is now for sale. The Verismo is a high pressure brewer for specialty coffees BUT it can also make regular coffee. It will steal business from Green Mountain regardless of what the CEOs both say.
CEO Howard Schultz continues to claim this is not a competitor to GMCR and they are still partners with GMCR but I think the clock is ticking on that deal. It may never end but I believe Starbucks will continue to bring new things to the single serve coffee market. Starbucks does not need GMCR. Green Mountain needs Starbucks. Unfortunately the patents on the K-cups expired last month and now anybody can make a K-cup and single serve coffee is going to get a lot cheaper.
In an interview Schultz said Europe appears to have bottomed and is starting to recover. He also hinted that sales in North America were also better than last quarter. With earnings four weeks away he has to be careful what he says. However, I think this will be a better quarter for Starbucks considering the last one was terrible thanks to the decline in same store sales in Europe. Add in some Verismo sales and revenue should increase. SBUX shares should move over resistance soon on expectations for Q3 earnings.
Wal-Mart (WMT) followed Target's (TGT) lead and kicked Amazon to the curb. Wal-Mart was selling the Kindle Fire tablets but they announced last week that they were halting sales of the products as soon as inventory was depleted. Personally I completely understand. Selling the Kindle to Wal-Mart shoppers is like giving them a portable cash register connected to Amazon. The book seller is no longer just a book seller. You can literally buy almost anything on Amazon and have it shipped right to your door. The new Kindles come complete with advertising when you turn it on and eventually there will be an ad that catches your interest and you will buy that item on Amazon instead of Wal-Mart.
Wal-Mart and Target are trying to slow down the trend towards showrooming. That means shoppers visit a retail store to compare products and then go home and buy it online. Best Buy is a prime example of a store that is hurt by showrooming and that is why we keep seeing the rumor about Amazon as a possible acquirer of Best Buy. That would give Amazon a bricks and mortar footprint where they could deliver thousands of products to consumers without the shipping hassle. Buy it here or buy it online, we don't care. I think it would be a good move for Amazon.
While on the subject of Best Buy I think they have the worst website in the world for a retailer. If you search for a specific product they not only give you the page for that product but they also list ads for that same product from other sites like Sears, Home Depot, etc. In theory that is to show that Best Buy's prices are the cheapest but anyone clicking away may lose focus and buy something on a competitor site.
Wal-Mart shares declined on the news they are halting sales of the Kindle but in reality it is not going to make much difference to the earnings of either company. The Kindle is a low margin, high cost, low turnover product for Wal-Mart so they won't lose. Amazon is selling all the Kindles they can make anyway so they probably won't miss Wal-Mart other than losing all those prospective Amazon shoppers.
I believe Wal-Mart shares are risky at this point. The spike up from May has stalled at $75 for two months now. If there is no breakout soon investors will get tired of waiting and abandon ship.
Kraft (KFT) left the Dow at the close and was replaced by United Health (UNH). United gained +1.24 on inclusion in the index and Kraft closed fractionally positive after a week of strong gains. Multiple analysts were reiterating buy ratings on Kraft because of the pending split into two companies and the projected increase in value.
Bank of America (BAC) said it was going to cut 16,000 jobs by year end. That did not get as much publicity as the news it had considered changing its name to remove the reference to America. I know that is a shock to some but a marketing team canvassed hundreds of bankers to ask if the bank should change its name to get more traction abroad. You know, overseas where 2.5 billion people dislike America. Was a brand with "America" hampering their attempts to establish a big footprint in emerging markets. One banker said in China people thought they were dealing with a government bank because it said Bank of America. That probably comes from their association with the government owned Peoples Bank of China. Eventually BofA decided to stick with the current name, "Bank of America Merrill Lynch."
BofA, JP Morgan and Citi have been under attack by Iranian hackers all year but those attacks increased last week as denial of service attacks. Analysts believe this is in retaliation for complying with sanctions against Iran. The country has beefed up its cyber capabilities since the Stuxnet virus hit its nuclear facilities in 2010. Iran has publicly advertised its intentions to build a cyber army and even encouraged private citizens to hack against Western countries. JPM and BAC websites were down as a result of these attacks for several hours earlier in the week.
Crude oil bounced after Thursday's contract expiration. The bounce was related to the November contract becoming the new front month and it had been trading at a slight premium to the expiring October contract. WTI hit $93.84 at the open before falling back to close at $92.90 for a 54 cent gain. Nothing changed in the outlook for crude prices to fall. It was just a contract change that caused the bounce.
However, Brent crude rose +1.39 on a new wave of weekend violence in the Middle East and Northern Africa. Brent closed at $111.48. The Brent contract expired on the 15th so there were no expiration pressures this week.
WTI Crude Chart
Gold rallied to $1790 intraday and very close to the high of the year at $1792.70. Powering the move was a decline in the dollar and some high profile calls for higher prices in the months ahead. Bank of America analyst, MacNeil Curry, said gold could peak at $5,000. "Ultimately we think gold will trade between $3000 and $5000." He said it "Certainly not within in the next few months but we are on a well defined uptrend, and we have got more to go before it runs its course."
Sabine Schels, senior director and head of fundamental commodity research at BoA, added, "The best long story for commodity markets right now is gold. In the type of aggressive monetary policy easing environment we have right now, you really want to own gold." Schels forecast gold prices will reach $2000 within six months, before rising to $2,400 by the end of 2014.
On Tuesday Deutsche Bank analysts, Daniel Brebner and Xiao Fu, predicted gold would reach $2000 in the first half of 2013.
Famed hedge fund guru Ray Dalio said on CNBC on Friday, "Gold should be a part of everybody's portfolio to some degree, because it provides diversification. It is the alternative money." Also, "We have too much debt. Too much debt leads to printing of money to make it easier to service. All those things mean that some portion of your investment should be in gold."
All of these comments are music to the ears of gold bugs. They really don't need any more conviction since current QE programs by the Fed, ECB, BOA, BOJ, PBOC, etc is flooding the markets with new money and the end result is going to be higher commodity prices.
Gold on the daily chart (not shown) completed a golden cross of the 50-day average crossing over the 200-day to the upside. The last time this happened gold was $950 in Feb 2009. The 50-day move below the 200-day in April with gold at $1650 on its way to $1525. This technical indicator is widely followed.
Pimco's Bill Gross believes the Fed will continue QE until unemployment falls to 6%. That could be a very long time. Gross said, "I am basically saying they are not going to exit. Bernanke has basically said if QE3 does not work, there is more behind this." He is projecting inflation to tick up to 3.5% in the next few years. I believe it will be higher and faster but he gets the big bucks for his outlook. He said a debt crisis cannot be solved by printing money. "In the process of reflation, the Fed and ECB will probably promote more inflation than real growth. That is what is really going to happen." However, "I don't think a debt crisis can be cured by more debt, but it can inflate an economy and stop deflation."
Minneapolis Fed President, Narayana Kocherlakota, suggested the Fed would keep rates low until the unemployment rate hits 5.5%. He believes that would likely take four years or more of QE and low rates. He said the behavior of inflation over the last 15 years suggested unwanted inflation is unlikely to kick in until unemployment falls near that level. "As long as the FOMC satisfies the price stability mandate, it should keep the fed funds rate extraordinarily low until the unemployment rate has fallen below 5.5%. The FOMC can provide more current stimulus if people believe liftoff will be triggered by a lower unemployment rate." He did not say what that additional stimulus would be. Kocherlakota, was a hawk and six months ago was urging the Fed to back off its low rate pledge. Suddenly he has reversed his position. I wonder what changed his mind. What does the Fed know that we don't know?
Chicago Fed President Charles Evans has urged the Fed to set unemployment at 7% or inflation at 3% as conditions for ending QE3 and otherwise continue it until either of those levels is hit.
Greece watching our elections? An EU-IMF report on Greece and the outlook for future disbursement of funds may now be postponed until after the U.S. elections in November in order to avoid a market shock. The report will show whether Greece can successfully continue with its reforms and continue to receive bailout funds from the EU or be forced to leave the eurozone. The EU denied the rumors the report could be delayed and an official in the Greek finance ministry said he had been assured there would be no slippage. However, a U.S. official said the U.S. had made it clear to European officials that is wanted to avoid any "downside" economic surprises for the next couple months because of the fragile U.S. recovery, but DENIED it had anything to do with the elections.
Several sources in Germany described those conversations with their U.S. counterparts and said the message had been clear that the Americans didn't want any surprises before the election. A Berlin official said it was "likely" the report would be pushed back until after the November 6th elections. It is widely believed that Greece is far from compliance with its promised reforms and the report will be seriously negative. "As far as European leaders are concerned, they don't want Romney, so they're probably willing to do anything to help Obama's chances," said the source, an EU official involved in finding solutions to the debt crisis. That makes me wonder why they want Obama. I will let you draw your own conclusions.
Friday was quadruple witching option expiration and the rebalancing of the S&P-500. This produced almost two billion shares of additional volume over the 6 billion share average for the prior three days. Friday saw volume of 7.865 billion shares. The rebalancing at the close saw 350 stocks that index funds needed to buy and 140 they needed to sell in order to maintain an equal weight with the S&P. Rebalancing is needed because of stock buybacks, secondary offerings, mergers, splits, major increases in market cap, etc. In theory the exercise brings everyone back into parity inside the S&P. Not surprisingly Apple and Google were on the buy list since their market cap had increased dramatically. This was the largest rebalancing since 2005. Trade volumes were expected to reach $33 billion.
The S&P declined into the close but for all the internal factors of witching and rebalancing it was a rather tame day. A close of -0.11 is hardly earth shaking and the decline for the week was only -5 points. On the surface it would appear we are just passing time waiting for the end of quarter window dressing to arrive next week. The only major move of the week came at the open on Thursday when the markets opened sharply down but quickly rebounded. The highest open interest for options on the S&P was 1450 and that is exactly where the drop ended and the rebound began on Thursday.
The S&P really gives us no indications of what to expect next week. It traded in a narrow range and gave back only a small portion of the post QE3 gains. We are consolidating in place, which is better than a 2-3 day drop because it is painless. Boring but painless.
I believe we are waiting for window dressing to begin. We are also waiting for the next headline to knock us out of our rut. That could be a bailout request by Spain or some new outbreak of violence, possibly closer to home. Who knows what it will take to end the monotony.
So far earnings warnings have failed to depress the bulls. Violence overseas has become so routine in just the last two weeks the market is not even phased. For instance YUM Brands announced it was closing more than 60 stores in Pakistan because massive anti-American protests forced them to take precautionary measures. McDonalds said it was closing 25 stores for the same reasons. I would bet the majority of our readers never even heard those headlines.
We are becoming immune to the news. Traders are still high on the QE3 drug even though it has just begun. There has been no post QE3 decline and that is slightly bullish. The S&P is holding just below multiyear highs and but it is not moving higher and that is troubling. How long can this consolidation of gains continue before traders become tired of no movement and move to the sidelines?
I see 1450 as initial support followed by 1435. Initial resistance is 1465. That gives the S&P a 15 point range in which to wander.
S&P Chart - 20 Min
S&P Chart - Daily
Taking a longer term view the weekly chart shows a bullish pattern of higher highs and higher lows. Resistance in the 1400-1425 range was broken and then the index fell back to test that level as support multiple times in August. That built a strong base and makes the 1400 level the likely stopping point on any major sell off. Below 1400 the 1350 level was major resistance in 2011 and is also strong support.
The breakout high after the FOMC decision has been in consolidation mode for more than a week without a major bout of profit taking. The longer term chart suggests we are going higher.
I know the earnings fundamentals are lousy, the economics are weak, the eurozone is likely to have some strong negative headlines in the coming weeks and the fiscal cliff is looming large but the market has priced this in with the dips in July and the last half of August. I know it makes no sense and as one analyst put it "we are whistling past the graveyard."
Ultimately price is the final arbiter of market direction. We have heard repeatedly that this was the most hated bull market in history and retail traders are not participating. We hear reports that fund managers are under invested. Fund flows into bond funds over the last year has set records and flows out of equities have been over $200 billion. Now those groups are faced with massive QE on a global scale never before seen. Cash is trash and bonds are barely yielding enough to keep up with inflation.
While I think all of the fundamentals in the market are negative we can't argue with price. The market can remain irrational far longer than we can remain liquid.
Despite the bull case I just made for the current market there is a good chance we will see some profit taking once the quarter ends. Fund managers will be free to take profits as they head into the normal period of portfolio restructuring ahead of their fiscal year end on Oct 31st.
Fund managers will decide during the October earnings cycle what stocks they want to hold over that 10/31 year end for statement purposes and which they need to liquidate. That includes losers they want to dump and winners they can use to offset the losers. If a stock like Apple has appreciated from $365 last November to $700 today then they have to weigh the potential for Apple to move higher against the losses the fund manager has to cover by selling winners. He can maintain a minor position in Apple to be able to look smart in the year end statements but he can cash out a large portion and that massive profit will cover a lot of losses in other positions.
That makes October a dangerous month since the markets are at their highs. There is a lot of profit at risk and markets RARELY move higher in early October for this reason. They do tend to rebound sharply from the October lows as managers pick up bargains other managers were forced to dump.
Expect window dressing next week but be wary of early October.
S&P Chart - Weekly
The Dow chart is a clone of the S&P although the blue chips have a subtle uptick not present in the S&P. It is extremely subtle and is probably because fund managers are using the blue chips as safe deposit boxes for cash going into quarter end. They know they can bail instantly in October without the same risk as putting money in illiquid small caps.
Resistance is the high at 13,650 and support at 13,500.
Dow Chart - 20 Min
Dow Chart - Daily
The S&P-100 (OEX) only lost half a point for the week. That is the 100 largest companies and this proves my point that blue chips are being used as safe havens for fund cash as we near the end of the quarter.
S&P-100 Chart - Weekly
The Dow Transports are not confirming the current market rally. They lost over -300 points for the week. The transports are suffering from the warnings from FedEx, Norfolk Southern and others about slowing freight and package shipments. NSC warned that commodity shipments were slowing along with intermodal shipments. Intermodal is the semi trailers that are shipped from one part of the country to the other. That represents consumer merchandise, manufacturing parts, etc. FedEx said global shipments were slowing even more than in their prior warning.
The Dow Transports are the canary in the coal mine for the U.S. economy. This is similar to the price of copper as the indicator of global growth and manufacturing. Nearly every electrical product has copper as a component and that includes homes and buildings. Low copper prices mean low economic activity.
The weakness in the transports is troubling and suggests at least a few investors are paying attention to the economic fundamentals.
Dow Transports Chart - Daily
Copper prices spiked two weeks ago when China said it was going to spend $57 billion on infrastructure projects. However, it has stalled and without an improving global economic story it is likely to fail at these levels.
Copper Chart - Daily
The Nasdaq managed to lose only 4 points for the week thanks to Google, Apple and Intuitive Surgical. Tech blue chips where places for fund managers to store cash. The Nasdaq chart is slightly different from the Dow/S&P. The Nasdaq rallied sharply since mid July and is more overextended than the broader market. This is due to the massive gains in Google and Apple powering a major percentage of the index. If those stocks bear the brunt of manager profit taking in October then the ride back down could be equally as violent.
Nasdaq Chart - 20 Min
Nasdaq Chart - Daily
Another factor that will support equities for the rest of the year is the rapid increase in dividends. Dozens of stocks per week are announcing larger dividends payable in Q4 in order to get ahead of the dividend tax hike in 2013. Unless Congress pulls a miracle out of their hat after the election the tax on dividends could rise from the current 15% to as much as 43%. Investors will buy and hold stocks for the next couple months to capture those dividends.
Goldman Sachs released a report on Friday saying they expect a wave of "special dividends" in the next few weeks to reward shareholders and unload some of the cash that has built up on company books. Goldman said nonfinancial companies have seen cash on hand rise +55% since 2007. Goldman said special dividend announcements tend to be concentrated in Q4 with nearly half of all the announcements since 2000 being made in Q4. In 2010 when the tax cuts were originally set to expire the number of one time announcements more than doubled the rate in prior years. Considering the uncertainty about the election and the fiscal cliff Goldman expects Q4 to set a record of special dividend announcements. Some stocks they felt would announce a special dividend included BEN, WYNN, TDG, WNR and GD to name a few.
This dividend cycle may be positive for stocks in general but we still have to live through the fiscal year end cycle for funds in October. If the market is declining those companies may wait for November to make their announcements in order to provide maximum lift for their shares.
To recap, I expect window dressing for the first three days of next week assuming no major negative headlines from overseas. However, fourteen of the last fifteen Mondays have been down on overseas news. I expect a dip in October most likely in the second and third week. The election could impact that depending on who is ahead in the polls at the time and the jobs numbers on Oct 5th. Not that jobs really matter given the Fed's recent move but it will still impact sentiment and the election.
Enter passively, exit aggressively!
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